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COMM 101
Sofy Carayannopoulos

Economic Factors(formulas in lab manual 7-9) Goals of Economic System Economic elements that influence business Economic Growth(measured by GDP, aggregate output) Balace Trade Exchange Rate National Debt Stability Inflation/Deflation Interest Rates Employment Employment rate and measures -> Affect costs, sales, financial uncertainty Financial System: Financial  ins▯tu▯ons  facilitate  flow  of  money Four pillars of Canadian financial system description roles/functions Chartered                      -­‐  Publicly -­‐  Serve  individuals,  business,  and  others Banks -­‐  Largest  and  most  important  ins▯tu▯on‐  Major  source  of  short-­‐term  loans  for  business (such  as   -­‐  Concentrated  and  highly  regulated  industry TD,  Bank  of Five  largest  account  for  90%  of  total  bank  assetsen you go to the bank and take out the Montreal) loan, you give them the right to sell your personal Bank  Act  limits  foreign-­‐controlled  banks  to  <8%  of   total  domes▯c  bank (allows foreign- belongings if you do not pay them back à lower interest controlled banks to increase competition; but than unsecured still limit the extent to which the foreign Unsecured  loans:  backed  only  by  the  borrower’s  promise  to   repay  it.  Only  the  most  credit-­‐worthy  borrowers  can  get   competitors to come in, to prevent population unsecured  loans investing money in foreign banks Determines  what  banks  can  or  cannot  do) Expand  money  supply  through  deposit  expansion Alternate Trust  companies  &  Credit  unions -­‐          Smaller  verBefore you couldanks. banks borrow/deposit money to them, but they weren’t (such  as  Canada   A  trust  company  safeguards  property   trustworthy/popular because they did not offer the Trust,  credit (funds  and  estates)  entrusted  to  it.  It  may  ervices. Now, they do not really exist. unions) also  serve  as  trustee,  transfer  agent,  and   unions: cooperative savings and lending associations formed by a group with common registrar  for  corpora▯ons  and  provide  interests. They lend to business and consumers. other  services. When you do things with CUs, you’re a member of that union. So when the union generates profits, you get a dividend à growing in appeal Specialized Insurance  co.,  venture  capital  firms,  pension  antial investors in real estate mortgages and lending/ funds in corporate and government bonds. saving - Largest financial intermediaries in Canada next to intermediaries chartered banks You  pay  premiums  to  the  insurance   companies à hence  they  share  risk  with   policyholders  for  premium.  They  then   invest  and  profit  from  the  money  by   lending  it à your  premiums  grow Investment Facilitate  trade  of  stocks,  bonds  and Motake  the  connec▯on  between  investors  and   Dealers products  in  Securi▯es  Markets companies                    (Where  stocks,  bonds,  and  other  securi▯es  are   sold)                      Primary  markets    stocks  and  bonds  are  securi▯es  because 3  important  things they  represent  a  secured  claim  on  the  part   of  investors)    Advise them on the timing and financial terms for a new issue: what type of security to                      Primary  markets issue, terms, price, other features –Investment  bankers/dealers 2. Underwrite (buying) the new securities à actually buy it from the corporation à Investment bankers bear some of the risk of                        Secondary  markets issuing a new security   - Toronto Stock Exchange and other exchanges 3. Create a distribution network that moves - Once the security leaves the investment the new securities through the banks and brokers into the hands of the individual bankers,they go there investors. - You have to contact the Ontario Securities Commission in order to control Secondary  markets what you do with your stock à every stock exchange you want to trade on, you must go - When you decide you don’t want those through a process shares/bond anymore, you will go to Toronto Stock Exchange (or other exchanges) to sell them - If you can’t afford to have stock on stock exchange, smaller market = over-the- counter: organization of securities dealers formed to trade stock outside the formal institutional setting of the organized stock exchanges o Disadvantage: lack of visibility à potential investors cannot see you o Advantage: it does not cost you Changes in banking industry                    Deregulation                    Lines  between  the  4  ▯inancial  pillars  have  been  blurred  due  to  deregulation                    Changes  were  made  to  the  Bank  Act                    More  competition  and  less  regulation  in  Canada i.e TD Canada trust Offer retirement services                    Changes  in  consumer  demands                              Banks  try  to  be  responsive  to  demands  to  remain  deregulated;  banks  respond  to  new  competition  by   selling  a  growing  array  of  services  in  their  branches                  Competition  from  foreign  banks Bank of Canada description • Canada’s  central  bank Manages  economy  and  regulates  aspects  of  chartered  bank  opera▯ons Manages  money  supply The banks’ bank , managed by the board of governors, and is crucial in managing economy     he Bank of Canada sets the interest rate. This is the rate at which chartered banks can borrow from the Bank of Canada. This influences how the other banks are going to charge us when we borrow, or how much they are going to give us when we save tools for affecting money supply Expansionary policy( stimulates business activity and increase money supply), Open market operations Buy government securities: These purchases increase bank reserves and their ability to make loans to business and consumers.The people who sell the bonds then deposit the proceeds in their banks. Bank Rate Lower the bank rate: By increasing the willingness to borrow, more loans to business and consumers can be made Restrictive policy( slow down business activity and decrease the money supply), Open market operations Sell government securities: These purchases decrease bank reserves and their ability to make loans to business and consumers. Bank Rate Raise the bank rate: By decreasing bank’s the willingness to borrow, fewer loans to business and consumers can be made.                    Interna▯onal  Banking  &  Finance   •Governments  and  corpora▯ons  frequently  borrow  in  foreign  markets •Interna▯onal  Bank  Structure –Aims  for  stability –World  Bank provides  limited  services,  funds  na▯onal  improvements –Interna▯onal  Monetary  Fund: •promotes  stability  of  exchange  rates •provides  short-­‐term  loans  to  members •encourages  member  coopera▯on •promotes  system  for  interna▯onal  payments                  Other  Investment  Vehicles •blue  chip stocks •small-­‐cap  stocks:  small  coopera▯on;  riskier;  expect  for  higher  return •penny  stocks •Canada  Savings  Bonds  -­‐  CSBs:  safe •Guaranteed  Investment  Cer▯ficates  -­‐  GICs:  like a  walk-­‐in  saving account,higher saving  interest  rate  (put  in  years) •Treasury  Bills  -­‐  T-­‐Bills •Mutual  funds:spread to  use variety,mixed  por▯olio Bonds : Represents  debt  for  issuing  corpora▯on  or  government(i.e.  Canada  Saving  Account) Characteristics                                        -­‐  Legal,  binding  agreement(a  wri▯en  promise  to  pay  the  lender  the  sum  +  interest) -­‐  Fixed  rate  of  return  (o▯en  paid  semi-­‐annually)               coupon  rate  of  the  bond  is  the  fixed  rate  of  return. -­‐  Fixed  term  –  principal  repaid  at  maturity  date -­‐  Priority  over  stockholders   If  the  business  goes  bankrupt,  people  want  their  money  back,  and  bond  holders  come  first,                        ahead  of  the  stockholders  in  terms  of  liquida▯on  and  repayment                    -­‐  The  value  of  principle  to  be  repaid  is  the  face/par  value  which  is  usually  in  $1000  denomina▯ons Types – -­‐  Securebacked  by  mortgages  or  asset)  vs.  Unsecured  (debentures) Registered bond: whoever issued the bond knows who the owner/lender of the bond is (they know who they’re sending the coupon payments to) à holder names registered with company them to the issuer (company) to receive the payment on the maturity date. clip coupons from certificates and send Features              Callable                    Issuers  have  the  rights  to  buy  bonds  at  a  price  specified  in  the  contract  before  maturity  date.                  They  are  likely  to  call  in  bonds  when  the  interest  rate  is  lower  than  the  rate  being  paid  on  the  bond.  But  the  call  price  usually  gives   a  premium  to  the        bondholder.                  Serial              bonds  the  company  will  issue,  but  they  do  not  all  mature  at  the  same  date                    Conver▯ble you can convert your bond to a common stock instead of cash repayment, because this makes bond more attractive to investors. Since this gives bondholders a chance for capital gains, the company can offer lower interest rates when issuing the bonds. If a company starts doing great things, it can benefit more from a stock because you become an owner. Factors affecting price 1) What  impacts  the  coupon  rate  at  bond  issue?                      Coupon  rate  will  always  be  higher  than  interest  rate.  The  bigger  the  gap  between  the  coupon  and  interest  rate,   the  more  a▯rac▯ve  the  bondà coupon  rate  NEVER  CHANGES. – Prevailing  interest  rates – Credit  ra▯ng  of  issuer Triple A rated companies means your bond is very safe with that company, so it is a safe investment, so lower coupon rate. But a lower bond rating means you need to attract investors, so use high coupon rate. •h▯p://www.moodys.com/ – Features(  e.x.  Time  to  maturity) 2)                    What  impacts  bond  price  when  traded? – Coupon  rate  &  prevailing  rates  of  interest  (rela▯onship) – Changes  in  credit  ra▯ng – Economic/Market  Risk – Infla▯on Yield -­‐    Percentage  return  on  any  investment(Helps  us  to  compare  investments) capital gain/loss: face value – price paid annual capital gain/loss: (face value – price paid)/time to maturity Yield=  what  made/what  paid                =  (interest  +  capital  gain)/what  paid Calculating approximate yield to maturity assuming it will hold until maturity (interest/bond/year + annual capital gain) / (price/bond) = ((coupon rate*face value)+[(face value - price paid)/time to maturity])/price paid Example: bought 6% bond for $850 with 10 years to maturity Yield = ((0.06 x 1000) + (1000 – 850)/10) / 850 = 8.8% In the case of a bond, there are 2 ways to make money 1. Capital gain or loss (benefit financially by buying an asset and selling it again) 2. Coupon rate Relationship between prevailing interest rates and bond prices Bond prices vary inversely with interest rates Interest rates up = investors expect higher yield à lower coupons are compensated for through a capital gain that is made possible by lowering the price of the bond Par: face value – price paid àwhen interest rate = coupon rate Discount:price paid < 1000 àcapital gain; coupon rate is less than interest rate Premium:price paid > 1000 à capital loss; coupon rate is higher than interest rate Bond quotations What  would  you  pay  for  a  GM    9.5  of 2023, if  the  yield  (prevailing  rate)  on  similar  risk  bonds  issued  today  is  10.5%? GM=  corpora▯on  that  issued  the  bond 9.5=coupon/interest  on  the  bond(indicates  coupon  payment) 2023=date  bound  matures                  =  date  that  bondholder  receives  face  value  of  $1000 R=10.5% Order Quan▯ty Issue  Type      Coupon Maturity   Price   Yield   DBRS/Moody/S&P Sell/Buy 250/250 Government  Of   CDA3.500  06/01/202 99.603/   3.54528/   AAA/  -­‐/  -­‐ Canada  Coupon  0 100.663   3.42539 Issuer         rate                     Yield  /  Change     *  Bonds issued  at  $1,000  face  value  and  redeemed  at  $1,000  face  value  at  maturity Stocks : Represents  equity/capital  for  issuing  company Characteristics: vo▯ng  rights no  fixed  term variable  return  à stock  prices  change discre▯onary  payment  (dividends)                          if  there  is  money  le▯,  shareholders’  representa▯ves  (BOD)  can  decide  to  distribute  a  por▯on  of  those   profits(dividend) à but  dividend  might  be  be▯er  to  keep  for  business risk: riskier  than  bonds  (bondholders  ahead  of  stockholders  and  have  legal  documents) For issuer: · Benefit: you don’t need to pay back stocks in the future or any time in between Downside: give up control and ownership Preferred stock: usually issued with a stated par value. Dividends paid on these are usually expressed as a % of the par value. Some preferred stock is callable, meaning the issuer can require stockholders to surrender shares for cash. The amount of cash is specified in contract · hybrid investment: there is fixed income from dividends and the volatility of common stock · No voting rights unless there are a number of missed dividends · Dividends are cumulative · Dividends are paid before common stock · Dividends have the participation feature: After common shareholders are paid dividends up to a certain amount, participating preferred stock holders get to share in the rest · In the case of bankruptcy, is paid after debt holders · Less volatile than common stock, but is sensitive to interest rates · Smaller market · Redemption feature – company can buy back the preferred stock Conversion feature – owner can convert to common stock Common stock: people buy firm’s common stock hoping it will increase in value & provide dividend · Has voting rights · Not necessarily given dividends, up to the board · In the case of bankruptcy, paid last · Most volatile in terms of price · Larger market than preferred stock Characteristics of Common stocks and preferred stocks COMMON STOCK PREFERRED STOCK “hybrid investment” VOTING RIGHTS Yes No – unless number of dividends unpaid DIVIDENDS Not necessarily Yes but only after interest paid on debt -“extra” dividend sometimes -cumulative given (Dir. Vote) -paid before common -participation feature BANKRUPTCY(priority) Paid after preferred Paid after debt holders PRICE VOLATILITY Most volatile Less volatile (dividends ) - sensitive to interest rates MARKETABI-LITY More shares, larger market Thinner market OTHER Right – more shares at set Redemption – co. can buy back FEATURES price Convertibility – to common TERM : no  fixed  term Factors that affect stock price Demand and supply of stock due to negative or positive perceptions/facts Primary factors 1. Earnings – above or below expectations, rumors 2. General market conditions – bull vs. bear markets, economy, interest (especially preferred) 3. Speculation – bought or sold on belief price will soon move PRICE  OF  A  SECURITY  IS  A  COLLECTIVE  EXPRESSION  OF  ALL  OPINIONS  OF  THOSE  WHO  ARE  BUYING  AND  SELLING Undervalued issue: offers higher return than stocks of similar risk; selling lower than it should. Stock quotations High     Low       Stock    Dividend      High     Low  Change       Volume vola▯lity        vola▯lity  last  price from  yesterday’s marketability lot   close •prices  $5  move  in  5  cent  increments If a stock isn’t traded: Bid: Highest price a buyer is willing to pay Ask:  Lowest  price  a  seller  is  willing  to  sell   Market Condition Bull market buyers are more eager to buy than sellers are willing to sell à forces prices up Bear market sellers are more willing to sell than buyers to buy à prices depressed Appropriate investing strategies: http://www.investopedia.com/articles/stocks/09/profit-in-bear-bull-markets.asp Leverage : Engaging  in  a  transac▯on  whose  value  is  greater  than  the  actual  dollars  you  have  available -> Creates  poten▯al  to  make  a  larger  return  or  loss  than  indicated  by  the  investment  you  have  made •Examples: selling  short  – deposit  50%  of  value  of  transac▯on buying  on  margin –  invest    part  of  value  of  transac▯on(margin  required)  borrow  the  rest Margin Buying (borrows of money) Concept Put  up  only  part  of  purchase  price Broker  lends  remainder  (with  interest) Min.  requirements  set  and  enforced  by  Securi▯es  Commission  -­‐    crash  of ‘29  -­‐  10% Rules • must  qualify  for  margin  account • must  sign ‘hypotheca▯on’ agreement  (Margin  Account  Agreement  Form)  -­‐-­‐  pledging  of  securi▯es  as  collateral  for   a  loan • must  pay  interest  on  loan • the  investors  %  equity  (margin)  in  the  margined  stock  must  always  be > the  minimum  margin  requirement (Current  Market  Value -­‐  loan)/Current  Market  Value     >    % margin    requirement When it makes sense specula▯ng  that  the  stock  price  will  rise Benefit: Able to buy more stocks/bonds for lessà potential for greater gains Potential losses and gains Potential gains/losses (downside )get larger Calculation of margin call and margin transaction Two  ways  to  calculate  margin  call: 1) Broker  is  only  willing  to  lend  30%  of  market  value CMV  =  $8,000  x  .3  =  $2,400  max.  loan current  loan  $2,700 therefore  reduce  loan  by  $300  (margin  call)                  2)                                                          CMV  –  loan)  +  margin  call >= margin req’t    CMV              ($8,000-­‐$2,700)  + ‘x’)  /  $8,000  =  70%                                                                                $5,300  + ‘x’    =  $5,600                                                                 ‘x’=  $300 Short Selling (borrows of shares) Concept Selling  when  value  is  higher  and  rebuying  when  value  is  lower Sell shares you do not own - borrow from broker Rules •  short  deposit  must  be  150%  CMV  at  all  ▯mes •Agreement may be terminated by either party at any time - forced to cover / “buy-in” •‘short sale price governed by ‘last sale’ rule you cannot short sell at a price below the price of the last transaction due to the downward pressure created by short selling                          •  dividends  declared  are  the  responsibility  of  the  seller When it makes sense Speculate  that  stock  prices  will  fall Potential losses and gains maximum  profit  can  be  made:  Price  of  short unlimited  losses: Anything  goes;  price  can  rise  infinitely - forced  to  cover  short  at  disadvantageous  price - short  callsay  be  declared  that  you  must  cover Calculation of short call and short selling Time Value of Money – application of appropriate formulae to problems One dollar today is worth more than one dollar tomorrow due to o Risk o Interest o Inflation Single Amount – Future Value Single Amount – Present Value Annui▯es: Multiple and equal payments over equal periods fo time Ordinary Annuity: Payment does not start today Annuity Due: Payment does start today Ordinary Annuity – Future Value Ordinary Annuity – Present Value Annuity Due = Ordinary Annuity * (1+r) Perpetuity: Annuity that goes on forever PMT = Face value * coupon rate R = prevailing interest rates Payments  and  Compounding  Periods If payment and interest rates match: (Payment every 6 months and interest compounded every 6 months -> n*2, r/2) If not (interest is compounded semi-annually, and you make monthly payments) - 1 · If stated as an APR, effective rate for a payment period = APR/ number of payment periods per year Bonds · PV Bond = PV Annuity of interest payments + PV face value Mortgages Ordinary annuities, payment monthly, interest semi-annually, with down payment,usually need to use effective rate Political Factors · Laws, regulations · Taxes · Trade agreements / sanctions · Political system · Political stability - Governments can create incentives, constraints, or support/bailout when needed - Affects uncertainty, risk, and costs/constraints faced by a firm How  government  influences  business Customer The government buys products and services – extremely large buyer so has high power Competitor Canada Post and CBC compete with other companies, tough competitor. as competitors, they can afford low prices(avoid), they are able to bargain for suppliers they want Regulator Regulates business activity, influences technology standards – What business can or cannot do ex. Wheat board: regulates the price farmers receive for their wheat CRTC: regulates all aspects of Canadian broadcasting system Purpose(4P1A): § Promotes competition – Competition Act, small business support § Promotes innovation – Intellectual property rights § Protects consumers – Hazardous Products Act § Protect the environment –Canada water act, fisheries act § Achieve social goals – Universal health care and education Taxation agent o Collected by all three levels of government(Federal,Provincial,and Municipal) o Types : Business taxes and personal taxes o Approaches: § Progressive: Tax rates increase as the person earns more – income tax § Regressive: Flat tax rate, takes a larger chunk of income for poor people – HST § Restrictive taxes –restricts goods such as cigarettes, gas, alcohol Provider  of   –Subsidies,  tax  breaks,  support  services  for  small  and  large  businesses,  research incen▯ves  &   funding(increase  innova▯ons) financial  assistanc–Bail  outs Provider  of  essen▯al   –highways,  armed  forces,  police  &  fire  dept.,  hospitals,  educa▯on services connection to other course concepts What  ac▯ons/decisions  can  government  make  that  will  affect  a  firm’s  ability  to  achieve  its  cri▯cal  success   factors?(elabora▯on  is  important) 6 Critical Success Govt. action and effect Factor Achieving financial Tax on specific items performance Meeting customer needs stimulates competition to provide choices to consumers with better prices/qualities to meet customers’ needs Protects consumers – Hazardous Products Act Building quality products laws,regulation & services (ex. patents usually have a certain expiry day to make sure products are new,useful and in-genuine ) Encouraging innovation patents/copyright/trademarks & creativity Intellectual property rights Gaining employee providing essential services commitment (ex. police services/highways to help business attract employees) Creating distinctive patent(technology) competitive advantage Porter’s Five Forces ex. suppliers: trade agreements affect whether to buy supplies from foreign supplier buyers: government as customer ,government as regulator protect customers potential entrants: government support small /new business existing rivalry: government ensure competition using regulations government itself as competitors substitute: government promotes competition Business influence over government – description • Lobbyists -hired  to  represent  company’s/group’s  interest  with government decision makers -Lobbying  Act  –  must  register  and  follow  rules -Trade  associa▯ons  –  Small  businesses/individuals  join  and  lobby  as  an  industry  lobby  group • Collabora▯on  with  government/decision  input –CRTC  consults  with  industry  members • Adver▯sing –Corpora▯ons  influence  voters  thus  influence  legislation Forms of business ownership Sole proprietorship(description) Owned and run by one person; business and owner are one and the same Legally, your business is considered to be an extension of yourself à can be small or large Advantages Disadvantages Complete control over profits and Taxed as personal incom : beusiness= decisions: don’t have to consult anybody owner, so personal income tax (higher on your choices or share your profits with than corporate tax ) anyone Unlimited liability: if you do not pay your Ease of formation: don’t even need to debts, the bank can come after the register business name. owner’s personal assets. Fewer regulations; takes time, money, Lack of continuity: If the owner retires, energy to form regulations the new business owner means the old Costs comply with regulations for small business ceases to existà customers may businesses; Small business cannot do not see the difference, but from a legal much damage due to small size à don’t perspective, the business changed need many regulations Limited managerial& financial Government support: wants small resources: few source of finance = businesses to set up whatever money you can obtain is what’s Tax benefits: most businesses suffer losses used at first. But since business=owner, losses Difficult to obtain outside financing: can be deducted from personal income banks do not want to lend money to sole
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